Car Buying Stalls, Can Consumers Keep Spending?

Americans may stay frugal after buying up SUVs with extra-long loans

By Justin Lahart

Jeep and Dodge vehicles displayed for sale at a Fiat Chrysler Automobiles car dealership. Photo: Daniel Acker/Bloomberg News


Americans are buying fewer cars. Will they buy something else?

Pushing steel is getting harder. General Motors , Ford Motor and Fiat Chrysler Automobiles FCAU 4.14%▲ reported on Monday that their car, pickup and other light vehicle sales were down sharply in June from a year ago. Japan’s top sellers did better, but not enough to make up for Detroit’s woes. At a seasonally adjusted, annual rate, auto makers sold 16.4 million light vehicles last month, according to WardsAuto, capping off the weakest quarter for sales since 2014.

Weakening auto sales have often been a prelude to the economy contracting. They began trending lower before the 2007 recession started, and were associated with the recessions of the 1970s and 1980s. The situation probably isn’t so dire now, but unless consumers shift the money they’ve been using to purchase cars to other areas, overall spending could weaken.

One common factor in those past downturns was higher gasoline prices, which not only prompted people to forgo car purchases—particular, lower mileage, made-in-America ones—but led them to cut back spending on other areas. With gasoline prices a bit lower than they were a year ago, that isn’t a concern at the moment. With unemployment low and incomes rising, it isn’t as if consumers have lost their ability to spend.

The recent decline in car sales stems in part from a drop in deliveries to rental-car companies, tighter lending standards and higher prices. It is also comes after a low-rate induced uptick in sales pricey SUVs and trucks, and as young people show less interest in cars than previous generations.



So Americans ought to have more to spend elsewhere, which would be good news for retailers, restaurants and other consumer-facing businesses with struggling sales. One hurdle to that, however, is that many people are still on the hook for the car they’re driving. The length of a new-car loan reached a record 69.3 months last month, according to Edmunds.com, with average monthly payments rising above $500. The rising share of new cars that are leased leaves people with more monthly payments to meet, either because they need to lease another car every few years or because they need to borrow money to buy the one they are leasing.

The slip in auto sales is also reflective of the more frugal consumer behavior that emerged following the recession. If people are shying away from car purchases they don’t see as strictly necessary, they are probably shying away from other purchases as well.


Another Lesson from Japan

Stephen S. Roach

Newsart for Another Lesson from Japan


NEW HAVEN – Yet another in a long string of negative inflation surprises is at hand. In the United States, the so-called core CPI (consumer price index) – which excludes food and energy – has headed down just when it was supposed to be going up. Over the three months ending in May, the core CPI was basically unchanged, holding, at just 1.7% above its year-earlier level.
 
For a US economy that is widely presumed to be nearing the hallowed ground of full employment, this comes as a rude awakening – particularly for the Federal Reserve, which has pulled out all the stops to get inflation back to its 2% target.
 
Halfway around the world, a similar story continues to play out in Japan. But, for the deflation-prone Japanese economy, it’s a much tougher story.
 
Through April, Japan’s core CPI was basically flat relative to its year-earlier level, with a similar outcome evident in May for the Tokyo metropolitan area. For the Bank of Japan (BoJ), which committed an unprecedented arsenal of unconventional policy weapons to arrest a 19-year stretch of 16.5% deflation lasting from 1994 to 2013, this is more than just a rude awakening. It is an embarrassment bordering on defeat.
 
This story is global in scope. Yes, there are a few notable outliers – namely, the United Kingdom, where currency pressures and one-off holiday distortions are temporarily boosting core inflation to 2.4%, and Malaysia, where the removal of fuel subsidies has boosted headline inflation, yet left the core stable at around 2.5%. But they are exceptions in an otherwise inflationless world.
 
The International Monetary Fund’s latest forecasts bear this out. Notwithstanding a modest firming of global economic growth, inflation in the advanced economies is expected to average slightly less than 2% in 2017-2018.
 
The first chapter of this tale was written many years ago, in Japan. From asset bubbles and excess leverage to currency suppression and productivity impairment, Japan’s experience – with lost decades now stretching to a quarter-century – is testament to all that can go wrong in large and wealthy economies.
 
But no lesson is more profound than that of a series of policy blunders made by the BoJ. Not only did reckless monetary accommodation set the stage for Japan’s demise; the country’s central bank compounded the problem by taking policy rates to the zero bound (and even lower), embracing quantitative easing, and manipulating long-term interest rates in the hopes of reviving the economy. This has created an unhealthy dependency from which there is no easy exit.
 
Though Japan’s experience since the early 1990s provides many lessons, the rest of the world has failed miserably at heeding them. Volumes have been written, countless symposiums have been held, and famous promises have been made by the likes of former US Fed chairman Ben Bernanke never to repeat Japan’s mistakes. Yet time and again, other major central banks – especially the Fed and the European Central Bank – have been quick to follow, with equally dire consequences.
 
The inflation surprise of 2017 offers three key insights. First, the relationship between inflation and economic slack – the so-called Phillips curve – has broken down. Courtesy of what the University of Geneva’s Richard Baldwin calls the “second unbundling” of globalization, the world is awash in the excess supply of increasingly fragmented global supply chains.
 
Outsourcing via these supply chains dramatically expands the elasticity of the global supply curve, fundamentally altering the concept of slack in labor and product markets, as well as the pressure such slack might put on inflation.
 
Second, today’s globalization is inherently asymmetric. For a variety of reasons – hangovers from balance-sheet recessions in Japan and the US, fear-driven precautionary saving in China, and anemic consumption in productivity-constrained Europe – the demand side of most major economies remains severely impaired. Juxtaposed against a backdrop of ever-expanding supply, the resulting imbalance is inherently deflationary.
 
Third, central banks are all but powerless to cope with the moving target of what can be called a non-stationary liquidity trap. First observed by John Maynard Keynes during the Great Depression of the 1930s, the liquidity trap describes a situation in which policy interest rates, having reached the zero bound, are unable to stimulate chronically deficient aggregate demand.
 
Sound familiar? The novel twist today is the ever-expanding global supply curve. That makes today’s central banks even more impotent than they were in the 1930s.
 
This is not an incurable disease. In a world of hyper-globalization – barring a protectionist relapse led by the America Firsters – treatment needs to be focused on the demand side of the equation. The most important lesson from the 1930s, as well as from the modern-day Japanese experience, is that monetary policy provides no answer for a chronic deficiency of aggregate demand. Addressing it is a task primarily for fiscal authorities. The idea that central banks should consider making a new promise to raise their inflation targets is hardly credible.
 
In the meantime, Fed Chair Janet Yellen is right (finally) to push the Fed to normalize policy, putting an end to a failed experiment that has long outlived its usefulness. The danger all along has been that open-ended unconventional monetary easing would fail to achieve traction in the real economy, and would inject excess liquidity into US and global financial markets that could lead to asset bubbles, reckless risk taking, and the next crisis. Moreover, because unconventional easing was a strategy designed for an emergency that no longer exists, it leaves the Fed with no ammunition to fight the inevitable next downturn and crisis.
 
We ignore history at great peril. The latest disappointment for inflation-targeting central banks is really not a surprise after all. The same is true of the related drop in long-term interest rates.
 
There is much to be gained by studying carefully the lessons of Japan.
 
 


Tectonic Shifts in Financial Markets by Henry Kaufman

A Wall Street veteran offers timely warnings on the fragility of institutions

by: Review by John Authers

 
 
 
Regulators and politicians have had a bad post-crisis. Financial markets recovered far quicker than expected after the disasters of 2008, and damage to the economy proved less than feared — outside the periphery of Europe — but the sense of injustice and anger has multiplied.

Far from taking advantage of the crisis to establish a sustainable financial order, politicians came up with complicated regulations, which Donald Trump appears likely to dismantle. No chief executive of a large financial institution had been prosecuted over events of 2008, until last week.

In Tectonic Shifts in Financial Markets, Henry Kaufman offers a scorching account of how Wall Street got into this mess, how it failed to get out, and what to do now. Coming from a pivotal figure in modern finance, now in his 90th year, it will command attention. Kaufman was at high school with Alan Greenspan; at the New York Federal Reserve with Paul Volcker; running research at Salomon Brothers as it created the US mortgage market and dominated bond trading; and on the board of Lehman Brothers in the years before disaster hit.
This book is not an autobiography. Neither is it a detailed manifesto for where we should go next. But the brevity of Kaufman’s proposals, and the force lent by his experience, should ensure that they are heeded.

His central point can be made with a scientific analogy. The laws of physics remain unchanged.

Credit build-ups will end with disaster, investment bubbles burst, and so on. But the geology of the ground, the tectonic plates, has shifted. This is because the nature of financial institutions has changed and, in Kaufman’s words, “we cannot go home again”.

Modern institutions are unfit to withstand potential dangers. So a different kind of regulation, involving greater intervention, more judgment, and far less trust for quantitative models, is needed to stop the behemoths from inflicting another financial crisis.

How did the plates shift? Compared with 1960, total US government debt has risen from $320bn to $17tn, while the 10 biggest financial conglomerates control 75 per cent of US assets — in 1990 it was 10 per cent. Financial derivatives, which barely existed in 1960, are now worth $630tn. The concentration of power, and increased disintermediation, mean that the person extending a loan or investing in a stock is no longer the person who loses if something goes wrong. These amount to tectonic shifts.

Some of the effects: when people talk about financial “liquidity,” they now mean that they have access to credit, not cash in hand; corporate debt has grown so much compared with equity that in any future crisis creditors stand to lose far more than in past crises; large investors cannot make shifts in their portfolio without disrupting markets; and only the central bank can now be trusted to provide liquidity, as all the biggest private-sector banks are so large and interconnected.

Kaufman is angry that the Fed, largely under Greenspan, failed to check the effects of the growth of institutions, and as a result found that its usual monetary remedies no longer worked.

He holds that the central bank will ironically have greater power — and become more political — as a result of past mis-steps. Rather than setting interest rates, which will need to be far higher to inhibit financial activity, he suggests the Fed will need to be far more intrusive in the few big institutions that wield the power, and which cannot be allowed to fail.

He is disgusted by what he sees as Barack Obama administration’s failure in 2009 to achieve reform. Banks had never been so unpopular, they were dependent on the government, and Mr Obama’s political capital would never be higher. Kaufman quotes Ron Suskind’s Confidence Men, which alleges that the Treasury department under Tim Geithner ignored an order from the president to prepare to nationalise Citigroup.

When Citigroup was created by the merger of Travelers Group and Citicorp in 1998, in a wildly popular deal, Kaufman was virtually the only voice to speak out, warning of dire consequences from excessively large financial conglomerates that have since come about. He was right then. It would be wise to listen to him now.


The writer is the FT’s senior investment commentator


Buttonwood

Fund managers rarely outperform the market for long

Sheer luck is as good as past returns in predicting future performance
THE big investment shift of recent years is from active to passive. Clients have been buying index funds, which passively track a benchmark like the S&P 500 index, and shunning fund managers who actively try to pick the best shares.

One reason for the shift is that passive managers charge lower fees than active funds. Many clients would be happy to pay more if that translated into better performance. However, it is very difficult for investors to select fund managers who can reliably beat their peers. Performance does not persist, as the latest data from S&P Dow Jones Indices show clearly.

Suppose you had picked one of the best-performing 25% of American equity mutual funds in the 12 months to March 2013. In the subsequent 12 months, to March 2014, only 25.6% of those funds stayed in the top quartile (see chart). That result is no better than chance. In the subsequent 12-month periods, this elite bunch is winnowed down to 4.1%, 0.5% and 0.3%—all figures that are worse than chance would predict. Similar results apply if you had picked one of the best-performing 50% of all funds; those in the upper half of the charts failed to stay there.

Perhaps this is an unfair comparison; fund managers cannot be expected to outperform every year.

But clients do hope they can deliver superior returns over the long run. So S&P Dow Jones Indices ran the numbers in a different way. Suppose you had picked a fund with a top-quartile performance in the five years to March 2012. What proportion of those funds would be in the top quartile over the subsequent five years (to March 2017)?

The answer is just 22.4%: again, less than chance would suggest. Indeed, 27.6% of the star funds in the five years to March 2012 were in the worst-performing quartile in the five years to March 2017. Investors had a higher chance of picking a dud than a winner.

The industry’s answer to this problem is to launch a lot of funds. Some of them are bound to be near the top of the charts and can be trumpeted in adverts; the losers can then be killed off.

Almost 30% of the worst-performing (bottom quartile) equity funds over the five years to March 2012 had been merged or liquidated by March 2017.

It should not be a surprise that the average fund fails to beat the index. The “iron law of costs” is that, in aggregate, professional fund managers own most of the stockmarket. Thus their performance is highly likely to resemble that of an index that tracks the overall market. But the index does not incur costs or fees; fund managers do. Thus the average fund manager must underperform the market, after costs.

Why doesn’t fund management conform to the rules of professional sports, where athletes such as Cristiano Ronaldo or Roger Federer consistently outperform their rivals? One reason could be that successful managers attract more clients, and the size of their fund grows. So they have to expand the number of stocks they buy, diluting their best ideas. As the fund grows larger, it looks more like the overall market, and runs into the iron law of costs.

A second possibility is that active managers tend to have a “style”, favouring particular types of shares. One style is the value approach, whereby investors seek shares that look cheap compared with a company’s profits, assets or dividend payments. But styles can go in and out of fashion as relative valuations change; value stocks can outperform for a while and then slump. So managers who follow that style will beat their peers for a period and then drop to the back of the pack.

The final possibility is that outperformance (or underperformance) is simply the result of luck.

Picking shares is enormously difficult, given all the potential factors involved. In the American stockmarket thousands of funds pore over the same information. It is very hard for an individual investor to get an edge.

Active fund management may have more of a role to play in other places: emerging markets, for example, where information about the prospects of individual companies is not so widely available; or bond funds, where S&P did find some evidence of persistent performance in areas such as mortgage-backed securities, municipal debt and investment-grade debt. In such areas, specialist knowledge may prove an advantage.

But when it comes to American equities, it is a different story. The average fund manager runs a portfolio for only around four-and-a-half years. So if you pick a fund based on its record, the chances are that a new person is in charge. The old saying that “past performance is no guide to the future” is not a piece of compliance jargon. It is the truth.


Why Failure Would Be a Virtue in Banking

It’s time to re-examine support measures and regulations put in place since the financial crisis

By Paul J. Davies




Profitability is still a struggle for many banks, especially outside the U.S.

It isn’t just about high capital requirements, low interest rates or poor investment activity. It is also about overcapacity: there are simply too many banks.

One big reason is that policy makers, perhaps unwittingly, have created barriers to exit, according to the Bank for International Settlements.

Support measures and regulations to protect the financial system that have been put in place since the financial crisis are propping up banks that in normal times would shrink, close down or get bought. Some of these need re-examining.

There are several ways to measure how banking capacity has changed. The number of licensed banks has fallen in both the U.S. and European Union since 2007—by almost 30% in the former but by just 16% to the end of 2015 in the latter, according to the latest data.

This hasn’t necessarily reduced capacity, though. The number of physical branches per 100,000 people has barely changed in the U.S., Japan and much of Europe, according to The World Bank. Spain has had a big decline, but still has far more branches than Italy and twice the number per head of the U.S.

So what is the issue? First, bank mergers and takeovers collapsed after the crisis and haven’t really recovered. In Europe, Mario Draghi, president of the European Central Bank, and Danièle Nouy, Europe’s chief bank regulator, have called for more consolidation. But executives aren’t biting. They are afraid of how regulators will treat them. Any big bank that grows in size and complexity is likely to face higher capital demands. That could hurt returns and limit dividend-paying capacity.

Another way of cutting capacity would be allowing banks to fail. In Europe, that still seems difficult, despite regulatory efforts to make it less so. This is down to political queasiness over enforcing the rules, especially in the weakest markets where failures are most likely, like Italy.

Spain has just forced through the resolution and sale of a failing bank, but Italy is still struggling to find a way around the rules and deal with several stuttering lenders large and small.

Overcapacity is a problem across Europe, more so than the U.S. Regulators can point out this problem. It would be better to start coming up with solutions, too.

Widespread deregulation isn’t the answer, but Europe should move faster to create a true single market for banking—like that in the U.S.. That would help consolidation the most.